WASHINGTON — In a move that could send interest rates higher, Fed Chairman Ben Bernanke ended weeks of speculation Wednesday by saying the Federal Reserve will likely slow its bond-buying program this year and end it next year because the economy is strengthening.
The Fed's purchases of Treasury and mortgage bonds have helped keep long-term interest rates at record lows. A pullback in its extraordinary $85 billion-a-month program would likely mean higher rates on mortgages and other consumer and business loans.
Anticipating higher rates, investors reacted Wednesday by selling both stocks and bonds. The Dow Jones industrial average closed down 206 points. The yield on the 10-year Treasury note rose to 2.35 percent. In early May, it was 1.63 percent.
Investors have been selling bonds and driving up yields since last month after vague signals from the Fed that higher long-term rates might be coming.
After a two-day policy meeting, the Fed upgraded its outlook for unemployment and economic growth. In a statement, the Fed said the "downside risks to the outlook" had diminished since fall. Fed members voted to continue the pace of the bond-buying program for now.
At a news conference afterward, Bernanke said the Fed would slow its bond buying later this year as long as the economy sustained its improvement.
He said the pullback in purchases would occur in "measured steps" and could end by the middle of 2014. By then, he thinks unemployment will be around 7 percent.
Asked why the Fed's statement made no mention of scaling back the bond purchases, Bernanke said he had been "deputized" to clarify the Fed's policy and how it might vary depending on the economy's health.
He likened any reduction in the Fed's bond purchases to a driver letting up on a gas pedal rather than applying the brakes. He stressed that even after the Fed ends its bond purchases, it will continue to maintain its vast investment portfolio, which will help keep long-term rates down.
The ultra-low borrowing rates the Fed has engineered have been credited with helping fuel a housing comeback, support economic growth, drive stocks to record highs and restore the wealth America lost to the recession. Investors now think the days of record-low rates are over.
"There's fear you'll see an expanding economy, which has a tendency to push up interest rates," said Jack Ablin, chief investment officer of BMO Private Bank.
Some investors worry that higher rates will cause investors to shift money out of stocks and into higher-yielding bonds. Others fear the economy might not be ready to absorb higher rates and that consumers and businesses could pull back on borrowing.
Talley Leger, a strategist at Macro Vision Research, said investors had become hooked on the Fed's efforts to keep rates at record lows.
"Markets are asking for expansion of already stimulative policies, and they're not getting it," Leger said. "It's like drug supplier and an addict."
Bernanke suggested that increased home prices and household wealth, a stronger construction industry and steady consumer spending would help support economic growth and offset higher mortgage rates.
"Generally speaking, financial conditions are improving," he said.
The Fed's more upbeat forecast helps explain why it thinks record-low rates may soon no longer be necessary. Low rates help fuel economic growth. But they also raise the risk of high inflation and dangerous bubbles in assets like stocks or real estate.
Timothy Duy, a University of Oregon economist who tracks the Fed, called its statement "an open door for scaling back asset purchases as early as September."